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Sovereign Wealth Funds: New challenges for the Caspian countries Summary This book considers fi nancial management and transparency aspects of Sovereign Wealth Funds (SWF). It also discusses the impact of the global fi nancial meltdown (2008-2009), commodity price fl uctuations and the rise of the risks in the emerging world on SWFs fi nancial performance and their investment activities. The book particularly concentrates on Caspian Basin countries (Azerbaijan, Russia, and Kazakhstan) plus Norway as explanatory case studies. Public Finance Monitoring Center Khazar university Address: Caspian Plaza 3; 44, J. Jabbarly str., Address: 11 Mehseti str., 9th fl oor Baku AZ1096, Azerbaijan Baku AZ1065, Azerbaijan www.khazar.org Tel/Fax: (+994 12) 497 89 67, 497 04 67 E-mail: offi [email protected] www.pfmc.az Baku – 2011 Acronyms EITI Extractive Industries Transparency Initiative GAPP Generally Accepted Principles and Practices GDP Gross Domestic Product IFI International Financial Institutions IMF International Monetary Fund NASDAQ National Association of Securities Dealers Automated Quotations NGOs Non-governmental Organizations NGPF Norwegian Government Pension Fund OECD The Organization for Economic Cooperation and Development SOFAZ State Oil Fund of Azerbaijan Republic SWF Sovereign Wealth Funds USD United States Dollar US/G7 United States Group Seven 3 Content Foreword ...........................................................................................................4 Sovereign Wealth Funds as the emerging players in the global financial arena: characteristics, risks and governance ................................................................6 Governance, transparency and accountability in Sovereign Wealth Funds: remarks on the assessment, rankings and benchmarks to date ......................47 State Oil Fund of Azerbaijan Republic: Past, present and future ...................................................................................73 The National Fund of the Republic of Kazakhstan (NFRK): From stress-test to global future.....................................................................100 Russian Sovereign Wealth Funds .................................................................130 About authors ................................................................................................159 4 Foreword Over the past decade, the boom in commodity prices, global imbalances between savings and investment in major countries and the massive accumulation of foreign exchange reserves have resulted in the rise of Sovereign Wealth Funds (SWF) as major forces on international financial markets and the global economy. In 2011, according to the SWF Institute, the largest Sovereign Wealth Funds manage well over $4 trillion in assets. The growing influence of SWFs has far-reaching consequences for both host and sponsoring countries. On the one hand, SWFs can play a positive role by financing development projects and serving as an instrument to shield economies against shocks. On the other hand, the economic weight of SWFs may hamper the implementation of effective macroeconomic policies and create additional opportunities for corruption in the sponsoring countries. Furthermore, the economic reach of SWFs engenders concerns about the potential destabilization of financial markets in host countries. Some Western governments are also concerned about transparency and politically motivated investments of SWFs. To address these issues, the International Monetary Fund, jointly with the International Working Group of SWFs, developed voluntary guidelines for the operations of SWFs in 2008. These principles, known as the Santiago Principles, were adopted by many SWFs, enhancing their overall credibility and strengthening transparency of SWF activities. The recent global financial crisis of 2008-09 elevated the importance of SWFs and temporarily shifted the focus of SWFs from long term investment issues to short-term economic stabilization. SWFs have helped to stabilize economies in a various countries such as Chile, Kazakhstan and Russia; and in some instances provided liquidity to troubled Western financial institutions. SWFs also experienced significant financial losses during the crisis which forced them to re-evaluate their investment strategies. The lessons from the crisis stress the need for strengthening risk management, financial regulation and achieving greater transparency. Specifically, SWFs tend to be more successful if their operations are integrated into the national development goals of their sponsoring governments. In addition, it is important for SWFs to provide adequate information to all stakeholders (particularly citizens, civil society groups and the media) and be accountable to public oversight bodies (national parliaments and supreme audit institutions). This volume advances our understanding of SWFs by presenting a critical analysis of resource-based SWFs in Azerbaijan, Kazakhstan and Russia. Based upon compelling evidence, this volume makes a strong case for the significance of transparency and accountability in strengthening the performance of SWFs. Most importantly, this volume discusses activities of SWFs from the perspective of nations that established these funds. The present volume pushes the boundaries of public oversight over resource revenue management by demonstrating that the Santiago Principles are insufficient to ensure full transparency and accountability 5 of SWFs. While SWFs in the Caspian region enabled the countries to weather the global financial crisis, their investment choices have failed to promote long- term development in countries that created these funds. Moreover, the volume critically reviews the existing methodologies of assessing performance of SWFs and proposes new criteria for evaluating performance of SWFs. This volume provides a valuable resource for anyone interested in assessing the recent performance of SWFs in the Caspian region. Antoine Heuty Deputy Director Revenue Watch Institute 6 Sovereign Wealth Funds as the emerging players in the global financial arena: characteristics, risks and governance Ingilab Ahmadov Public Finance Monitoring Center, Azerbaijan. Stela Tsani The Centre for Euro Asian Studies, University of Reading, UK. Kenan Aslanli Public Finance Monitoring Center, Azerbaijan. 1. Introduction Since 1997 the world’s markets have been experiencing the toughest financial crisis since the 1930s. The financial architecture that was considered to be the basis of the economic welfare of the world is collapsing. Under this crisis saving commodity windfalls in several resource-rich countries has mitigated the impact of commodity price volatility while it has helped several countries to smooth the impact of the ongoing financial crisis. The debate around the “invasive” nature of the Sovereign Wealth Funds has been growing prior to the emergence of the financial crisis being very much a US/G7 concern focusing on the risk of having opaque state controlled foreign investment vehicles possibly taking over strategic economic interests in developed economies. Nevertheless, this has not proved to be the case in the G7 countries where the drying up of investments has added a new shift to the ongoing debate. Developed countries are reconsidering the role and the investment operations of the Sovereign Wealth Funds, looking at possible investments from the latter into developed economies. In this reality the need becomes apparent for a thorough and profound understanding and discussion on the governance of the Sovereign Wealth Funds at the domestic level, on the accountability of the saving and the spending decisions to the citizens and on the role of the legislative bodies in overseeing the management of the Sovereign Wealth Funds. Furthermore, the economic implications of investing windfall gains abroad also have to be clarified. While this does shelter resource-abundant countries from commodity price volatility, it does little to change the structure of the economy and to sustain a public investment strategy aimed at increasing human development and long-term sustainable sources of growth inside the respective domestic economies. In the presence of the ongoing financial crisis, financial liquidity constraints may force even those countries that have been successful so far to resort to this type of investment. Besides, the fact that these assets are possessed by economically unstable and politically unpredictable countries causes serious concerns by the world community. 7 The nature of the investment policy of the Sovereign Wealth Funds substantially changes during (and possibly after) financial turmoil. If previously the primary goal of the Sovereign Wealth Funds was considered to be the transparency of windfall funds and their preferable management abroad, at the present and in the case of the exigency to stimulate the economy in natural-resource-rich countries, the management of these assets domestically becomes an imperative. This in its turn can darken the actual evaluation of the government on the withdrawal of the country out of the crisis and worsen the problem of ensuring the accountability of public finance management, thus increasing unlimited transfers and bailout plans. Thus, the ongoing crisis considerably changes the role and the philosophy of the Sovereign Wealth Funds and it introduces the need for a thorough understanding of these institutions. The most important impediment to the understanding of the Sovereign Wealth Fund remains the absence of
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